The cash conversion cycle, with an Australian example

The cash conversion cycle is how many days pass between money leaving your business and money coming back. It is three numbers added together, it takes about four minutes to work out, and most owners have never seen theirs.

Stock days, plus debtor days, less creditor days. How long the goods sit before they sell, plus how long the customer takes to pay, less how long you take to pay your own supplier. The last one is subtracted because that is your supplier funding you.

A real one

A business turning over $2.4m with $1.46m of cost of sales. It made an operating profit of $165,000 and it went backwards in cash by $23,000 over the same year. Both of those are true at once, which is the thing that catches owners out.

Ninety-one days. Three months between the business paying for something and being paid for it, every time, on everything. That gap has to be funded by somebody, and in the absence of a facility it is funded by the business, which is why the profit and the bank balance disagree.

Working capital consumed $220,000 over the year here. The business earned $165,000 and put $32,000 of depreciation back, and the working capital movement was larger than both together. That is the whole story of the year in one line.

What a day is worth

This is the part that turns the number into a decision. Told the cycle is 91 days, an owner has no idea whether that is worth an afternoon or a quarter. Priced per day, it is obvious.

So a week off the debtor book is about $46,000. Getting stock from 85 days to 70 is about $60,000. Those are numbers an owner can decide about, and 91 days is not.

The cheapest money in the business

This business invoices on 30 day terms and gets paid in 47. That 17 day gap is $112,740 sitting in other people's bank accounts, at no interest, with no application, available to anyone who is prepared to make some phone calls.

It is the cheapest capital available to a trading business and it is the last place most owners look, usually after they have been to a lender. Nobody enjoys ringing customers about money. It is still the highest paid hour in the week.

Worth being precise about what this is. Closing that gap releases $112,740 once. Next year, at 30 days, it releases nothing further. The business is permanently better off and it does not receive the money again.

What it does to what you can borrow

Nothing. This surprises people and it is worth being blunt about, because acting on the wrong assumption costs a quarter.

Borrowing capacity follows earnings. Collecting faster does not change what the business earned, because the sale was made and the margin was made and the profit was already in the accounts. What changed is when the money arrived. So an owner who needs a larger facility and spends three months on the debtor ledger will finish with more cash in the account and precisely the same capacity as when they started.

That is not an argument against doing it. Cash is the reason a business survives the quarter and a facility is a different problem. It is an argument against expecting one to solve the other.

How the cycle reads in a lending file

The length matters less than the direction and the composition. A cycle that is long and stable in an industry where that is normal is a fact about the industry. A cycle that has stretched twenty days over two years is a question, and the question is whether the business is losing control of collections or funding growth out of the trading account.

Inside the number, the debtor ageing gets read closely. A ledger where most of the balance sits inside terms reads as a business with systems. A long tail beyond 90 days reads as a business that does not chase, and that tail is usually discounted out of the security position entirely.

Creditor days are read in the opposite direction and more harshly. Stretching payables against flat revenue says the business is funding itself from its suppliers, which is the cheapest and least stable credit there is, because it can be withdrawn without notice and generally is at the worst possible moment.

Where to start

Work out your three numbers, price a day of each, and then decide. In our experience the order is almost always debtor days first, because it is the most valuable day and the one with the least operational consequence, then stock, then a hard look at whether you are paying suppliers earlier than you agreed to.